Winners and losers under Obama’s tax plan

Wealthy taxpayers will pay more while lower-income families will benefit, but the Tax Policy Center’s analysis also finds a few surprises.

In his 2015 State of the Union address, President Obama offered a series of ideas aimed at promoting “middle class economics,” including expanded tax credits for child care and for lower-income workers, and a proposal for free community college.

To help finance these ideas, the President also proposed to raise taxes on the wealthiest American households as well as to impose a new tax on financial institutions.

Just how big will the hit be for wealthy households, and how much will the middle class benefit?

Here’s the bottom line from a recent analysis of the impacts of the President’s proposed plan from the Tax Policy Center:

Low-income single workers and working-age households with children stand to benefit the most;

The average middle-income household would see a change in their taxes of less than $100; and

The taxes paid by the richest one percent of households would increase by an average of $27,000 (and for the richest 0.1 percent by an average of $156,000).

According to the Tax Policy Center, lower-income households would particularly gain from two elements in the Obama plan: (1) a proposal to double the refundable Earned Income Tax Credit (EITC) for single workers without children; and (2) a proposed expansion of the American Opportunity Tax Credit (AOTC), a partially refundable tax credit that helps pay for post-secondary education costs.

Nevertheless, the net tax benefits to the poorest American households won’t be enormous: households in the lowest income quintile would see an average tax benefit of $177.

Among middle-income taxpayers, the households that benefit most would be working-age households with children. Under the Obama plan, these households could benefit from a new nonrefundable “two-earner” credit for married couples and from a proposal to double the Child and Dependent Care Tax Credit from $3,000 to $6,000 per child, as well as the expanded AOTC.

Overall, however, the average tax benefit for all households in the middle-income quintile would be $12, according to the Tax Policy Center, while households in the fourth highest income quintile would see an average benefit of $91. (This figure, however, masks the fact that while some middle-income households could gain a lot, other households – i.e., those without kids – may see no benefit at all.)

For wealthy households, the tax hits would come from a proposed limit on the balances that can be accumulated in IRAs and employer-sponsored savings accounts and increases in the top tax rate for capital gains and dividends to 24.2 percent (up from its current rate of 20 percent).

The table below summarizes the distributional impact of all of these proposals (not including the impact of the financial institutions fee, discussed separately below):

Impact of President Obama’s proposed tax plan, not including financial fee

While the Obama plan would largely accomplish its goal of making the tax system more progressive, the Tax Policy Center’s analysis also reveals a couple possibly unintended quirks.

The first is that while the top income quintiles would bear the brunt of the proposed increases in taxes on capital gains, a small percentage of middle-income households – 0.1 percent to 0.2 percent – would also be hit. Moreover, says the Tax Policy Center, as much as 2.5 percent of the total change in tax burden would be borne by taxpayers with negative income (such as from business losses).

While these figures may not seem like much, this minority of affected taxpayers may belong to an especially vocal group: small business owners. (This means that if the Obama plan becomes legislative language marked up in Congress, look for a targeted carve-out.)

The second surprise in the Tax Policy Center’s analysis is the potential impact of the fee on financial institutions, which the White House says would affect roughly 100 firms. However, the Tax Policy Center says, “[t]he burden of taxes is ultimately borne by people, not firms”:

…[A]ssuming that the financial tax is ultimately borne by investors in the form of lower after-tax rates of return and workers in the form of lower wages…. part of the burden of the tax ultimately falls on relatively modest-income retirees who have pensions or 401(k) plans. Those households do not benefit from the tax cuts, which are focused on workers and families with children.

Once the impact of the financial fee is taken into account, the impact on middle-income households of the Obama plan switches from an average benefit of $12 to an average increase of $7, as this table from the Tax Policy Center’s study shows:

Impact of President Obama’s proposed tax plan, including financial fee

Nevertheless, the biggest hits would still be at the top – 98 percent of households in the top one percent would face higher taxes (versus 48 percent of households in the middle quintile). The Tax Policy Center is also careful to note that this analysis is based on certain assumptions – and that different assumptions could lead to different results.

Critics of the Obama proposal will either cast its impacts as a tax hike for the middle class or – even more cynically – exaggerate its benefits for low-income Americans. Neither assertion would be justified.

On the other hand, proponents of the plan might be tempted to overstate its benefits for the middle-class. And while some middle-income families may in fact benefit significantly, those benefits are in fact fairly narrowly targeted.

What is clear, however, is that the President’s proposal would generally restore greater progressivity to the tax code and generate additional resources that the government sorely needs.